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The Role of Consumption in U.S. Recovery

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (TheStreet) -- Consumer expenditures run at about 70% of GDP, so consumption growth will play an important part in determining the pace of U.S. growth. What do we know about the determinants of consumption growth?

Economists say consumption is driven by income: the more you make, the more you spend. Alternatively, income falls when you lose a job and so you spend less. But the composition of U.S. income is quite special. What makes it so is and how this will influence U.S. growth is discussed below.

The "Wealth" Effect

In addition to income, economists talk about "the wealth effect" -- the fact that consumption is also influenced by changes in wealth. In Table 1, data on disposable personal income and two types of wealth assets are presented: real estate and equities. Changes in household real estate assets came from the Fed's Flow-of-Funds Accounts. Equity totals include the changes in equity, mutual fund and pension fund assets from the same source.

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Looking at the annual changes in realized and unrealized capital gains provide an approximation of two wealth changes. There is no sure way to determine how much these changes affected consumption. But certainly, the growth in wealth from those two sources put upward pressure on U.S. consumption.

So I have added together disposable income and the wealth changes to come up with a total income figure. Note how important the wealth changes were relative to disposable income in the 2004-2006 period. There is no other country in the world where such a large percentage of household wealth is in equities.

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Everyone felt tremendous. Home values were growing and whenever we checked our portfolios, they were up. Of course, we all knew that the wealth changes were reversible, but times were good.

Table 1

In 2006, we see the slowing of the growth in real estate assets. In 2007, the real estate cycle turns down. Consider next what happened during the bank collapse/global recession years. As Table 2 indicates, capital losses in 2008 exceeded disposable personal income. As one might expect, there was a real "wealth effect," and consumption fell sharply. I previously estimated global wealth losses at $50 trillion, and as a consequence, global consumption plummeted.
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